Tuesday, July 29, 2008

For all of the glamour and allure surrounding the Venture Capital industry, one would expect the investment returns from VC funds to be significantly higher relative to other investment vehicles that are more widely available. However, industry research indicates that over time, venture capital returns have been roughly equal to the stock market in general. Indeed, over half of all venture capital-backed companies fail and roughly the same 50% of all money invested in venture capital funds is lost. This blog post discusses how a comprehensive IP management strategy could help VC firms lower their risk and increase the return in their respective funds.

According to some conversations I’ve had with people in the VC industry, the statistics above don’t tell the full picture. In addition to half of the venture funded companies that fail, there are those that are described as the “walking dead” – companies that neither go out of business, nor ever provide the substantial returns needed to satisfy typical VC models. One panelist I saw at a venture conference last year suggested that for their financial model to make sense, they needed at least 1 out of 10 companies to provide a 20x return on their investment. This could be especially troubling for the industry, given the emerging trend towards fewer and lower valued liquidity events.

But what if a venture fund could extract incremental investment returns from their portfolio companies, including the failed companies and from the so-called walking-dead companies? I believe a comprehensive cross-portfolio IP management strategy could provide increased returns to venture investors.

IP Due Diligence to Lower Business RiskVC’s typically invest in companies at the earliest stages of their respective life cycles. At the point of making the investment decision, the venture capitalist is placing his or her bet on the business idea, the management team; and whether they know it or not, they are also placing a bet on the IP which underpins the business.It is critical that VC firms perform proper and adequate due diligence in support of their investment decisions. Sorry, but simply having a list of patents and applications is not enough. Investors need to understand whether or not the patents are strong patents, with adequate coverage for the business and the technology in question. The following quote sums it up better than I can:

These all-important questions should be answered during the investor’s due diligence. Be warned however, that topographical patent landscape maps or other abstract visualizations do not represent a sufficient level of analysis. They may be an improvement over a simple list (although some might argue that point), but a proper analysis must involve a detailed examination of patent claims in the context of the business and of the technology in question. There are a bunch of good blog posts on this subject on the IP Asset Maximizer Blog.

IP Portfolio Management to Lower Costs & Increase MarginsAlthough most of the portfolio companies financed by a given venture fund will be relatively small, and have a relatively small portfolio of patents, it may be worth it for the VC to look across the entire IP portfolio in aggregate.

I did a quick analysis of a couple regional VC firms – with relatively small portfolio’s of companies, these firms had an invested interest in over 300 and 600 patents. By corporate standards, these are sizeable portfolios. I would expect to find even larger portfolios with larger venture firms.In businesses with portfolios of this magnitude, it is important to understand the portfolio in multiple dimensions. For example, IP professionals, marketers and business leaders want to know what IP assets support which products. Knowledge of these relationships can allow a company to block competitors, lower costs, raise margins and ultimately increase returns to investors. In addition, they will want to categorize their patents by the markets and technology areas they serve, as it helps them understand if their patents align with the business focus.

Bringing this discipline to IP Portfolio management has the added benefit of revealing patents that are not core to the business of the company. With this knowledge in hand, a typical company will seek to lower costs by letting patents expire, or they may seek to sell or out-license their non-core patents, thus creating a new source of revenue.

IP Licensing to Increase Returns Patents that are not core to the business of the owning company may still be valuable to other companies and other industries. There are some well-known examples of companies who have been able to generate significant revenues from their non-core patents through active licensing programs -- Companies like IBM and Qualcomm come to mind. However there are a number of other companies that have generated significant returns by monetizing their non-core IP assets. Mindspeed and AMCC are two recent examples:

In the case of a VC portfolio of companies, each company may only have a small number of non-core patents. But across the portfolio of companies, the venture firm may have rights to a significant number of patents that may be valuable to other companies/industries.

We can extend the concept of monetizing non-core assets of the top companies in the venture portfolio to the “walking-dead” and even the defunct portfolio companies (although with these latter two groups, we may worry less about the distinction between core and non-core patents). In many cases, the business model and the due diligence supporting the original investment in these were probably sound, but the business failed due to execution or market timing issues. In many cases the underlying IP assets may still be fully valid, valuable and available for entry into a focused licensing and monetization program.

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